Why do so many small businesses fail?

Sean Page asks: Why are so many small businesses sunk by poor cash flow and what changes to the financial regulatory framework could help prevent these closures? I surprised myself here when I first looked at the question I though wow that’s way out of my depth, but then I realised I actually know the answer. In the last 9 months since I decided to set up as a freelance artist, I’ve actually been reading a lot of business books, networking like crazy and asking a lot of questions from people who have started their own businesses.

The business owner’s personal failure to project his or her own cash flow

One of the first things you learn when writing a business plan is knowing when your money is coming in and when it is going out. There are pitfalls such as having to pay large sums in government taxes or even operational bills going out at an unexpected time. It is important to take account of this. A particularly nasty problem with the British government is that the first time you pay tax they can sometimes ask for money in advance that you don’t have yet, based on your projected income for the first year. So it’s very important to keep track of your business finances.

Customers not paying on time

If customers are slow to pay it could potentially leave deficit in a cash flow meaning you can’t pay your bills. A quick fix is to borrow more money to plug the gap, but that could damage your business in the long run, because that’s another deficit, to your cash flow. Chasing them down or making sure you have a float to absorb the transaction can overcome this.

Not having an adequate buffer in the bank

If you have a sufficient amount of money that just stays in the business bank account, this simply lubricates the transition of one payment to the next. You should never actually have to worry about cash flow problems (unless your business is actually not making any money) For example: Recently I had an art show but some of my paintings ended up being damaged and thus could not be sold. However this quite significant loss of earnings was absorbed because I had a sufficient buffer with which to keep things fluid until my next commission. This has meant that I am still in business. However it is important to replenish the buffer immediately so it is there ready for next difficulty.

What changes to the financial regulatory framework could help prevent these closures?

The above problems are really the responsibility of the business owner to solve. However changes to the regulations for bank lending money to small businesses, might actually have a detrimental effect rather than a positive one. For instance banks should avoid lending money to businesses who do not plan to have a buffer to lubricate cash flow as part of their business plan; there are basic financial principles that are missing. Banks should offer advice on cash flow when considering loans.

A change that could be also made, at least in Britain, is that the government could stop asking for money based on projected earnings. It should only ask for tax based on real earnings.

Well that's my take on why so many small businesses fail. I hope you find this useful.